Target turnaround taking hold

Target Corp.’s efforts to turnaround its business appear to be taking hold — at least based on its better-than-expected first quarter performance.

The discounter broke through the gloom that has characterized many other retailers’ first quarter results with earnings and sales that beat the Street and its own expectations. The company also gave a brighter outlook for the full year.

Target's net income rose to $681 million in the quarter ended April 29, from $632 million a year ago. Excluding items in the latest period, Target earned $1.21 a share, easily beating analysts' estimate of 91 cents per share.

“Target’s first quarter financial performance was better than our expectations, reflecting strong execution by our team as they delivered for our guests in a very choppy environment,” said Brian Cornell, chairman and CEO of Target. “After starting the quarter with very soft trends, we saw improvement later in the quarter, particularly in March.”

Target plans to spend $7 billion over the next three years to remodel stores, speed up expansion of small-format stores in urban markets and college campuses, bolster online operations, and lower prices. The retailer also plans to launch 12 new brands over the next two years. The first new brand, a home décor and bedding/bath line called Cloud Island, will roll out later this month, the company said Wednesday.

“We are in the early stage of a multi-year effort to position Target for profitable, consistent long-term growth, and while we are confident in our plans, we are facing multiple headwinds in the current landscape,” said Cornell.

“As a result, we will continue to plan our business prudently while preparing our team to chase business when we have an opportunity.”

Neil Saunders, managing director of GlobalData Retail, commented that Target’s foremost issue is the quality of its stores.

“These (the stores) are far too functional, change too infrequently, and offer very little in the way of inspiration,” he said. “Such a position means that Target struggles to pull in customers – something our data shows is getting worse over time, especially among younger millennial consumers.” For more of his comments, click here.

Target said it expects second-quarter earnings of 95 cents to $1.15 a share, compared with an average projection of $1. And it expects earnings above the midpoint of its previous forecast of $3.80 to $4.20 a share.

Analysis: Target’s top issue is the quality of its stores

At headline level, Target's results are a lot better than feared. The pace at which total and comparable sales are declining has eased over the prior quarter, and the company helped itself to a 7.7% increase in net earnings. Against a tumultuous retail backdrop, this is a not so terrible performance.

That said, the better than expected numbers are not all down to operational prowess on Target's part. The milder fall in total sales is down to the company lapping weak comparatives from the prior year when, following the sale to CVS, the removal of pharmacy sales dragged down performance. On the profit front, the uplift in earnings is primarily a function of reduced interest expense, which fell by 65.3% over the prior year.

When these points are factored in, the fault lines in Target's business model become more apparent. Comparable sales continue to slide, gross margin is down by 2.5%, and traffic and conversion at stores both slipped on the prior year. While we would not suggest that Target is as broken as many other retail businesses, we do believe that there are many aspects of the operation that are sub-par.

The foremost issue is the quality of Target's stores. These are far too functional, change too infrequently, and offer very little in the way of inspiration. Such a position means that Target struggles to pull in customers – something our data shows is getting worse over time, especially among younger millennial consumers.

Fortunately for Target, the tedious nature of stores does not extend to its non-food ranges. Target's selection is, both in our view and when rated by consumers, compelling, of reasonable quality, and excellent value for money. The high proportion of own-brand across areas like home also helps to differentiate the company from retail rivals. The issue is that more and more consumers are discovering and buying this range online rather than in stores – something that is exacerbated by poor availability and frequent out-of-stocks in shops.

This trend is evident in the numbers. This quarter, Target's total store sales were down 1.9% on the prior year; online sales rose by 21.5%. The comparable numbers show a similar picture with Target's stores contributing -2.2% to the overall decline. The two issues flowing from this are online sales are margin dilutive because of the cost of fulfillment, and shoppers who use the online channel tend to buy less frequently and are more disciplined in their approach and less likely to succumb to impulse buying.

So the key challenge for Target is to get more people into its stores and to sweat its real estate much harder. In our view, this will not only help sales but will also ultimately aid profitability.

Fortunately, Target is now more focused on shops and has announced a comprehensive store remodeling program. From what we can see in the initial plans, the proposed changes look sensible and should give Target more of a destination status. However, we also believe that Target should not wait for the refurbishments to elevate the store experience; there is much more it can do in the here-and-now to create excitement and interest. An example is the Victoria Beckham range which launched during this quarter. The range itself was a success, the execution in most Target stores was lackluster and dull. It is the age-old tale of Target not showcasing its wares with enough pizzazz.

As much as we believe Target will struggle over the remainder of this fiscal year, we also believe that its difficulties will be mild compared to many other players. Certainly, there are challenges on grocery, as we have discussed in previous notes, and these may worsen as margins are crimped from discounting in a more competitive market. However, the offer remains sound, and this alone should help to take the edge off the declines.

Longer term, the store refurbishments and general improvements to the business should yield results. While Target has been criticized for pulling back on some of its more futuristic initiatives, we believe that it is right to channel investment into getting the basics right. At this time, Target needs to fix its shaky foundation, not build ivory towers on top of it.

Urban Outfitters Q1 profit falls 60%

Urban Outfitters reported disappointing results for its first quarter, weighed down by heavy promotional activity at its namesake and Anthropologie banners.

The company’s net income fell 60% to $11.94 million, or $0.10 per share, down from $29.56 million, or $0.25 per share, in the year-ago period. Analysts had expected the company to earn $0.16 per share,

Sales for the quarter ended April 30 edged down 0.2% to $761.2 million from $762.6 million last year. Same-store sales declined 3.1%, a bigger drop than expected, despite strong gains in online revenue. By brand, same-store sales rose 1.5% at Free People, but fell 3.1% at Urban Outfitters and 4.4% at Anthropologie Group. Comparable retail segment sales were driven by strong, double-digit growth in the direct-to-consumer channel, which were offset by negative retail store comparable net sales. Wholesale segment net sales increased 14%.

“During the first quarter we continued to see strong double-digit growth from our direct-to-consumer channel and our wholesale business," said Richard A. Hayne, CEO. “We believe we have significant opportunity to continue to grow both of these channels at all of our brands.”

Håkon Helgesen, analyst at GlobalData Retail, commented that Urban Outfitters growth in its direct to consumer channel came at the expense of stores.

“A particular issue here is that it costs Urban more to fulfill from its online operation than it does from a store, so the direct channel's cannibalization of sales is costing the company margin and hurting profits,” Helgesen said. “In our view, while general footfall challenges in some locations are causing pain, Urban's rather cluttered and confused approach to merchandising is also partly responsible for the decline of its stores. While Urban Outfitters and Anthropologie stores are not unpleasant places to shop, neither do they make the process of buying easy. The customer has to do a lot of work in finding the right product, which is one of the reasons increasing numbers are opting to buy online where sorting and filtering options make it easier to identify items of interest.”

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